Sunday, April 02, 2006

Bargain basement or meltdown?

Are newspaper stocks at bargain-basement levels or merely at a subterranean stopping point as they melt ever closer to the core of the earth?

In the interests of full disclosure – and so you can conveniently calibrate the quality of my insights by consulting the stock tables fast disappearing from newspapers but now readily available at Google and many other online locations – you should know that I was one of the lonely guys in the last few weeks who bought shares of McClatchy, Knight Ridder and Scripps while the stock market was pummeling most of publishing group.

Now you know where I stand on the question posed in the opening sentence.

In the interests of even fuller disclosure, I also want to report that I served as an adviser to one of the private equity firms that considered buying Knight Ridder when it went up for sale late last year. Apart from the posting immediately below, I stopped writing this blog during the engagement. Any comments regarding Knight Ridder in this post or any subsequent items will be based solely on publicly available information.

Although the very best days for newspaper companies arguably have been behind them since the first TV stations went on the air, the industry has the commercial strength, growing resolve and emerging wisdom to refit its estimable franchises as significant competitors in the 21st Century and beyond.

The compelling reason to buy newspaper stocks at this time is that they have fallen to historically low levels. As of March 20, the Morningstar investment advisory service reports, “the media sector was dead-last over the five-day, year-to-date, one-month, three-month, one-year, three-year, and five-year periods.”

The combined value of the publicly traded newspaper stocks dropped $2 billion in the first three months of the year to $70.8 billion, as detailed in the table below. The aggregate decline is but $278 million short of the entire enterprise value of McClatchy (MNI, $48.85), which bravely – and, I would argue, astutely – is buying two-thirds of Knight Ridder (KRI, $63.21). KRI was forced to the auction bock by investors displeased with the desultory performance of its shares.

To give you a sense of how far the once-mighty newspaper stocks have fallen, Lee Enterprises just 14 months ago bought the St. Louis Post-Dispatch and the rest of the Pulitzer chain for 13.5x EBITDA (earnings before interest, taxes, depreciation and amortization). That’s roughly 28% less than the 9.5x EBITDA that MNI intends to give for KRI. In 1990, if memory serves, McClatchy paid something north of 20x EBITDA for some papers it coveted in South Carolina.

Notwithstanding this comeuppance for publishers, it is worth noting that more than a third of the stocks in the Dow Jones Industrial Average actually trade at lower values than the price at which KRI is slated to change hands.

If the $6.5 billion KRI transaction is completed on the originally announced terms, the target will be sold at approximately 9.5x EBITDA, a value greater than that of such DJI companies as Verizon (4.5x EBITDA), Exxon (4.9x), Intel (6.2x), Home Depot (8.5x), Pfizer (8.5x), AT&T (8.6x), McDonald’s (9x) and Du Pont (9.2x). Stock prices, of course, climb when investors think a company is about to be taken over. Thus, it is fair to note that the valuations of any of the companies used in this example would rise significantly if they went into play.

With MNI trading at 7.1x EBITDA and the newspaper group rated at an average 9.1x EBITDA, even a quantitatively challenged journalism major like me can see the potential upside. Doing the math, I also determined that KRI is trading at approximately $2 per share less than MNI has promised to pay for it. Yes, there is risk that MNI may stumble in selling the dozen newspapers it has elected not to keep, but early indications are that several parties are interested in them.

Succumbing to the same bargain-hunting mentality that inspired my purchase of MNI and KRI, I bought Scripps (SSP, $44.71) when it recently hit an air pocket. Unlike MNI and KRI, which are pure newspaper plays, SSP, which derived only 27% of its sales from newspapers in 2005, has become one of our leading "un-newspaper" companies.

Perhaps the most prescient of its peers in envisioning a future of targeted, narrowcast media and unlimited consumer choice, SSP years ago launched the successful HGTV the Food cable networks. It then acquired the Shopzilla online shopping service and recently bought uSwitch, a UK-based company that helps consumers shop for loans, credit cards and such services as utilities, telecommunications and cable TV.

If you think the shrewdest thing for a newspaper publisher to do is to get out of the business entirely, then the most visionary of all is Thomson Newspapers. Thomson unloaded all of its newspaper assets by 2001 and has turned its attention to delivering financial data, medical journals and other specialized trade publications.

Although Thomson could be right, the rest of us could be wrong and newspaper stocks could continue to fall to ever-lower lows, the fundamental business proposition remains appealing.

Newspapers typically enjoy near-monopoly franchises, control the largest share of advertising dollars in a market, attract the most traffic of any local web site and, even in the most challenging markets, generate strong, consistent and reasonably predictable cash flows. Not many businesses can boast that.

Although there is widespread fear that competition from the Internet will kill newspapers, I actually think it has the potential to make them stronger. But don’t take it from me. Here’s what Morningstar had to say:

We actually believe that in a world filled with way too much information – much of it inaccurate – delivered via more media and channels than any one consumer can possibly manage, the editorial skills found in the newspaper industry could prove to be very valuable.

Study after study has shown that the average consumer actually doesn’t like to have too many choices, which is exactly what the Internet provides. In the long run – and recent research suggests that this has already started – consumers will gravitate to a handful of trusted information sources for their news.

We suspect that newspapers like The New York Times, The Washington Post, and The Wall Street Journal will benefit from this, as will local newspaper publishers.

For the sake of our democracy, if not to mention my meager stock portfolio, I hope Morningstar is right.

About Me

Alan D. Mutter is perhaps the only CEO in Silicon Valley who knows how to set type one letter at a time.
Mutter began his career as a newspaper columnist and editor at the Chicago Daily News and later rose to City Editor of the Chicago Sun-Times. In 1984, he became No. 2 editor of the San Francisco Chronicle.
He left the newspaper business in 1988 to join InterMedia Partners, a start-up that became one of the largest cable-TV companies in the U.S.
Mutter was the COO of InterMedia when he moved to Silicon Valley in 1996 to join the first of the three start-up companies he led as CEO.
The companies he headed were a pioneering Internet service provider and two enterprise-software companies.
Mutter now is a consultant specializing in corporate initiatives and new media ventures involving journalism and technology. He ordinarily does not write about clients or subjects that will affect their interests. In the rare event he does, this will be fully disclosed.
Mutter also is on the adjunct faculty of the Graduate School of Journalism at the University of California at Berkeley.